Entertainment industry: A cloud up in the air

As DVD sales dive, what next for movie studios?

Sign of uncertain times: big film studios along with retailers and electronics groups are backing a venture to offer a ‘rights locker’. Buyers of a movie online will be able to stream it to a device of their choosing as well as share it

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Executives at Universal Pictures thought they had a hit on their hands. The Hollywood studio had been offered the chance to turn Stephen King’s best-selling The Dark Tower series of books into a trilogy of films and a spin-off television series.

The omens looked good: the movies would have a vast, ready-made fan-base, thanks to the popularity of the book series – a sprawling fantasy epic with echoes of The Lord of the Rings. Ron Howard, a renowned director, was lined up to direct; Oscar winner Javier Bardem was on board to star.

Yet at Universal’s recent “greenlight” meeting to decide whether to put the project into production, the studio’s senior management balked at the cost. “The economics just didn’t work,” says a person familiar with the project.

The rejection of such a hotly anticipated proposition would have been unthinkable five years ago, when Hollywood studios were swimming in cash. Back then, booming DVD sales had brought a spike in productions: even films that flopped at the box office would make their money back when they were released on DVD.

Times have changed. DVDs used to generate more than $20bn a year but since 2006 sales have fallen by more than $6bn, while attempts to reverse the decline with a new format – higher-quality Blu-ray discs – have largely failed. Hollywood is now betting that the consumers who stopped buying physical discs can be persuaded to buy films digitally.

But new sales data and analysis of buying patterns raise big questions about whether consumers are willing to spend money to own film and TV content at all, regardless of the format. For an industry desperate to avoid the grim fate of the music business, this presents a serious problem.

At stake is America’s biggest cultural export. The most recently available figures from the Motion Picture Association of America show that Hollywood generated a $11.7bn trade surplus in 2008, larger than industries such as telecommunications, consulting, legal and insurance services.

So far, the studios have done a poor job of persuading consumers to buy online – mainly because of the popularity of renting. “What Hollywood wants and what the consumer wants is diverging,” says Arash Amel of IHS Screen Digest, a research firm that recently produced a report on digital movie sales. “The studios now want you to buy movies digitally and to own those movies. But the consumer wants access to film and TV programming without the burden of ownership.”

The last time the Motion Picture Association of America studied the effect of copyright theft in Hollywood was 2005, when it found that piracy was costing the industry more than $6bn a year in lost revenues. Since then, the growth of fast broadband has made piracy more difficult to contain and when one illegal web site closes, another one opens up.

Creative America, a new coalition for the entertainment industry, says piracy has resulted in the loss of 140,000 jobs in the US. It estimates that websites trafficking in stolen film and television content receive about 150m visits every day.

If he is right, Hollywood’s latest technological venture – a project the studios hope will restore the industry to its cash-rich glory years – could be doomed even before it formally launches this autumn. Universal, Warner Brothers, Paramount Pictures and Sony Pictures – all of the big studios, apart from Walt Disney – are backing the venture, a cloud-based “rights locker” and authentication system called Ultraviolet. It has the backing of big retailers in the US such as Best Buy; technology groups such as HP, Intel and Cisco are on board, as are phone makers like Nokia and Motorola. Apple, like Disney, is conspicuous by its absence; the two are working on their own cloud-based rights locker.

The companies involved in Ultraviolet have much to gain if it takes off: consumers will in theory buy more movies, much to the delight of retailers, device makers and the studios. Ultraviolet is a simple enough concept: the studios are convinced consumers will begin buying films in digital formats in large numbers if they are able to stream them remotely from cloud-based servers. They argue that cloud-based streaming is more appealing than downloading and storing titles on a hard disc, because video files take up lots of space.

Ultraviolet will give consumers their own rights locker: buying a movie online will give them the right to stream it from the cloud to any device of their choosing, such as a smart phone, a tablet computer, a PC or an internet-enabled television. The studios hope this will stimulate digital sales – or “electronic sell through”, as it is referred to in Hollywood.

“We have to make EST easier,” says Rick Finkelstein, chief operating officer of Universal Pictures. “If you can store a movie in the cloud and watch it on any device, that’s a great consumer proposition. And you don’t have to watch it in 24 or 48 hours, like you do with rental.”

The problem with digital film ownership today is the lack of interoperability between devices: moving files is clunky and impractical, which has held back sales, according to Mitch Singer, president of Digital Entertainment Content Ecosystem, the consortium behind Ultraviolet.

With Ultraviolet, that “friction” disappears, he adds. “Consumers are telling us loud and clear that if they could access their film libraries on any device that they may own – or want to own in the future – then they will continue to collect movies.”

Parents who have bought electronic or physical copies of films will be able to share them with family members hundreds of miles away with the click of a mouse. “I have a high level of optimism that if we make it possible for consumers to collect movies, then they will continue to collect,” says Mr Singer. “EST isn’t dead …we just haven’t offered consumers something they want to collect yet.”

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Yet for all of the enthusiasm, Ultraviolet increasingly looks like a last throw of the dice for an industry desperate to preserve its retail business model. It is clear why Hollywood wants to keep selling movies: the profit margin on a DVD sale is more than 65 per cent – close to double the margin on a rental. Selling an electronic format is even more profitable because there are no manufacturing costs and minimal distribution costs.

But consumer behaviour has changed radically in the five years since DVD sales reached their peak, making it difficult to predict demand for a cloud-based rights locker. After all, consumers hardly lack choice when it comes to streaming movies or online TV programming.

Netflix, the US-based DVD and online movie streaming service, for instance offers an unlimited mix of older movies and newer titles to rent by streaming online for a fixed monthly price: in the last five years the company has grown from a niche operator to the dominant player, with more than 25m subscribers. Most of its customers are in the US but the company recently unveiled plans to launch in 43 countries across Latin America and the Caribbean. Availability in Europe is due to follow.

In the last five years, movie studios and online retailers have also experimented with selling downloads of their films online, with Apple’s iTunes store the largest outlet. But in each country where movie downloads have been made available, sales plateau after an initial flurry of interest, says IHS Screen Digest. The numbers are not large. Outside the US, online movie revenues in 2010 were just $243m, according to data compiled by the media research company – a small fraction of the revenues generated by the rental and sale of physical discs.

There is increasing evidence that manufacturers and retailers have given up on movie downloads. Apple is the world’s largest digital film retailer, representing 55 per cent of all global online movie transactions, yet the latest version of its Apple TV device does not have a hard disc: viewers who want to watch movies have to rent them digitally and stream them to the box instead. Globally, more than 30 online retailers have stopped selling films online in countries including Canada, Germany, France and Italy. In the UK, LoveFilm and the BT Vision Download store have stopped selling digital movies – although LoveFilm continues to rent titles.

Digital rental, also known as internet video on demand, continues to be popular, however. “Consumers want to rent, not buy, in a digital world,” says Richard Greenfield, an analyst with BTIG Research. “There are so many ways to access content – why would you ever need to actually own a movie?”

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Whether a cloud-based service can persuade consumers to resume buying movies as opposed to renting them is up for debate. Many in Hollywood think the problem is related to pricing: at more than $15, buying a digital copy of a film seems expensive when it can be rented from the same online store for $3 or $4 – especially when you consider that most people watch a film just once.

“Retail sales are not dead, although the performance of the industry has not been good,” says John Calkins of Sony Pictures Entertainment. Hollywood “has not managed the digital retail model successfully”, he adds, while the placement of rental titles in online stores alongside films that are for sale has not helped. “It’s not rocket science to work out that the consumer will want to rent, not buy.”

He advocates price cuts to bring buyers back. It often costs more than $15 to buy a newly released film online: Sony recently cut its wholesale prices and saw a sales uplift, he says. “If new titles were priced at $10-$15, people would buy them. If you were planning on renting for $4, buying for $10 doesn’t look so bad.”

Others, such as Mr Singer, say Hollywood should explore changing so-called release “windows” – the periods of time between a film’s release in cinemas, on DVD and on pay-TV. At the moment, new movies can be rented or bought in the same window. But if they were made available to buy online several weeks before they were released to rent, that could boost sales, he says.

Could such measures revive the sales model? Proponents of Ultraviolet say Hollywood has a fighting chance. “Consumers still want to watch film and television shows,” says Mark Teitell, general manager of the DECE consortium. “They still want to spend time watching content …it’s not like they’re saying: ‘I don’t care about movies any more’. That would be much worse.”

The problem is there are an increasing number of ways to watch movies illegally, with illegal web sites that offer free movies “growing in sophistication, consumer reach and quantity”, according to Screen Digest’s Mr Amel. Piracy could further dent the industry’s plans to revive EST. With that in mind, and the wide availability of films to stream on a rental basis, convincing consumers to buy movies again will be hard.

“In a world where the internet exists, the power no longer rests with the studios,” Mr Amel observes. “The web has empowered consumers and ultimately the studios will have to come into line with what consumers want, rather than what is best for Hollywood. After all, that’s what happened in the music industry.”